Fuel for thought on Boris' big VAT idea

By Editor on 2 June 2016

The ears of the Chartered Institute of Taxation were pricked by the debate this week about VAT on energy bills and the EU.

Leading figures in the campaign for Britain to leave the European Union by way of the June 23 referendum say they want to be able to scrap VAT on fuel to help the poorest households through lower bills. Conservatives Michael Gove and Boris Johnson, along with Labour's Gisela Stuart, wrote in a national newspaper of their frustration that EU rules prevent the UK from doing this.

Up until now the rules have been that countries have been allowed to keep VAT exemptions and reduced (including zero) rates where these were negotiated at the point of joining the EU but there are significant restrictions on removing goods and services from VAT. These mean that under current rules the UK has been able to reduce VAT on domestic fuel and sanitary products to a reduced rate of five per cent but not to remove it altogether.

It is true that the UK could scrap VAT altogether if there was a Brexit but it is highly unlikely because VAT is now well established and understood and viewed by economists as a relatively economically efficient tax. It also one of the biggest revenue earners for the Government, with VAT raising in 2015-16 about £116 billion - more than over 20 per cent of government revenue.

Another issue that the end of VAT would produce is the question of how to replace it, probably with a sales tax or some form of purchase tax.

Scrapping the tax would go against the current trend of more and more countries moving to VAT systems.

However, if we left the EU, then we could choose without any restrictions the rate at which VAT applies to goods and service, such as making an item zero rated.

But reduced rates and exemptions come at a cost – other rates may have to rise, a line of argument goes.

The UK can scrap VAT on energy bills if it left the EU. In fact, if the UK leaves the EU, it can scrap VAT on anything. However, there are moves by the EU to give member states more flexibility on VAT. And we must be wary of the assumption that less or no VAT on energy will lead to lower bills because that relies upon companies passing on the saving to customers rather than taking it as extra profits.

In April, the European Commission published an Action Plan on VAT, a move further toward a single European VAT system, based on the ‘destination principle’, that is goods and services are taxed in the country where they are consumed.

The European Commission also announced a consultation with member states on proposals to allow countries to vary their reduced VAT rates on items such as: e-books; women’s’ sanitary products; domestic ‘green’ expenditure; children’s clothing; and basic foodstuffs. One option would be the establishment of a list of goods and services on which reduced (including zero) rates could be introduced by any country. Another option would simply give complete freedom to the member states to select any goods they favour for reduced rates.

The counter-argument to a more flexible VAT regime is that the more variation there is between different countries’ VAT rates and other rules the more complex doing business across borders becomes.